IRAs are great for accumulating retirement funds and rolling over 401(k)s on a tax deferred basis.  Deferred is the operative word here.  Ultimately, either you or your heirs will pay income tax on the entire balance.  Income taxes could easily eat up 40% of your Required Minimum Distributions (RMDs).  Your heirs could owe even more – as much as 70% of your IRA between income and estate taxes!

On the other hand, Roth IRAs are income tax free.  Your heirs may still owe estate tax, but no compounding of income and estate taxes.  Anyone can convert an IRA to a Roth IRA- but, you have to pay income taxes on the IRA, which discourages most of us from doing so. 

But, what if you could convert your IRA to a Roth IRA and pay ZERO income tax?  Yes, I said zero – nada, none!  Before I tell you how, let’s look a little farther at the advantages of Roth versus Traditional IRA:

1. You have more after-tax money in a Roth. If you have $1,000,000 in an IRA, it is worth about $600,000 after taxes.  If you have $1,000,000 in a Roth IRA, it is worth one million after income taxes.
2. There are no RMDs at age 70.5. Nothing has to be taken out until your heirs receive it.  If you do not need the money right away, this allows for greater compounding.
3. Your heirs only have to take out RMDs based upon their life expectancy, meaning the pot can continue to grow after death, if the rate withdrawn is less than the earnings.
4. Any time you need money, you can take out only what you need from the Roth – you do not have to gross it up for the taxes.

I’ll take a Roth IRA over a regular IRA any day of the year!

Here is the plan.  You have $400,000 in an IRA, and you also have $400,000 in non-qualified assets, some of which may have substantial appreciation.  You also give $20,000 per year away.  What if you decided to bunch your contributions up front for a few years to gain some tax advantages? 

Gift $100,000 of appreciated assets each year, creating an income tax deduction and avoiding capital gains tax.  In the same year, convert $100,000 of your IRA balance to a Roth IRA, creating a taxable event.  Your charitable contribution offsets the tax due on the conversion!  In four years or so, you have converted all of your IRA to a Roth IRA!

Now you have a tax free pool of money in your Roth IRA worth $400,000 and growing.  At 70.5, you are not required to take distributions, but if you do, they are tax free.

Not only that, but if you gift your appreciated asset to a donor advised fund, you have a tax free pool of money from which to make your charitable contributions every year.  This reduces your cash flow needs, taking pressure off other assets to generate income.

If you run the numbers, you might just find this to be an awesome financial strategy for your chartable clients.

Published October 24, 2019